Friday, July 24, 2009

Cash for Clunkers and the Broken Window Fallacy

The Consumer Assistance to Recycle and Save (CARS) Act (a.k.a. Cash for Clunkers) was passed and signed into law last month and can now be implemented thanks to the publication today of rules by the National Highway Traffic Safety Administration (NHTSA). I was going to write about this proposed (at the time) law a while ago, but I honestly didn't think such idiocy would actually pass the Congress. My bad.

The CARS program pays people up to $4,500 for buying a new car if they trade in an old car which gets 18mpg or less. This already sounds like a pretty dumb and pretty obvious government handout to the auto industry. Wouldn't it be nice if the government could just be honest and hand out cash to their favored industries and lobbyists? It would certainly save a lot of time and resources to pay off your political supporters in a straightforward way.

It gets worse, however, because some in Congress have actually convinced themselves (or at least their constituents) that the purpose of the CARS Act is to reduce fuel consumption and carbon dioxide emissions by getting cars with poor gas mileage off the road. Therefore, the old trade-ins must be destroyed. The following excerpt from the NHTSA's rules is practically Orwellian:

The agency has determined that a quick, inexpensive, and environmentally safe process exists to disable the engine of the trade-in vehicle while in the dealer’s possession. Removing the engine oil from the crankcase, replacing it with a 40 percent solution of sodium silicate (a substance used in similar concentrations in many common vehicle applications, including patching mufflers and radiators), and running the engine for a short period of time at low speeds renders the engine inoperable. Generally, this will require just two quarts of the sodium silicate solution. The retail price for two quarts of this solution (enough to disable the largest engine under the program) is under $7, and the time involved should not substantially exceed that of a typical oil change. The agency has tested this method at its Vehicle Research and Test Center and found it safe, quick, and effective. As with many materials used in the vehicle service area of a dealership, certain common precautions need to be taken when using sodium silicate. The same is true with regard to workers who may come in contact with the substance during the crushing or shredding of the engine block. We have discussed the matter with the EPA and the Occupational Safety and Health Administration (OSHA) and are aware of no detrimental effects related to the disposal of the engine block with this material in it.

I'm surprised that they don't require the cars to be buried and then the ground above sown with salt.

The CARS program has been variously described as an economic stimulus, as good for the environment, and as a way to reduce our dependence on foreign oil.

If one gives this even one minute of thought (something that Congress apparently did not), it becomes clear that, except for war, vengeance, and spite, no good could possibly come from destroying something of economic value. There is something called the broken window fallacy, introduced by Frederic Bastiat in 1850, and I refer you to the following link for a discussion.

Unfortunately, the CARS program is essentially a program to break windows. It encourages society to destroy all eligible clunkers with market values up to $4,500.

As we can infer from their market value, clunkers in fact have an important role to play in our economy and our society. They can actually move people and stuff from place to place at reasonably high speeds, and to the extent that a significant majority of people in this country can't actually afford to buy a new car, or even a slightly used one, clunkers allow those people to enjoy the fruits of a technology that has been around for the last hundred years.

This law is particularly annoying because the cutoff fuel efficiency for clunkers is 18mpg, and my 2000 Buick Regal gets 19mpg. The market value is probably barely higher than $4,500, but I figure I could have smashed a few things, collected the insurance money, and then traded it in.

5 comments:

Anonymous
said...

I agree with your analysis that it is pure fiscal stimulus, and rather inefficient. But one should also put some value on the pollution that is avoided by scrapping the old car. If all car owners had to buy carbon credits dependent on the emissions, many people would have bought a cleaner car a long time ago. In (parts of) Europe, there is a highly progressive road-tax linked to engine size, effectively a carbon tax. Regards, AYBABTU

I agree only to the extent that the negative external effects of owning clunkers are not incorporated into taxes on such cars or the gasoline that they burn. The main negative externality is that clunkers burn more gas, and gas is underpriced because the subsidy provided by the US Navy in making sea lanes safe for oil tankers is not incorporated into the price of oil (from which gas comes). It may also be true that the negative effects of pollution and carbon emission (both somewhat speculative) are not properly accounted for by the current tax on gasoline in the US. Another negative externality is that clunkers are more likely to break down on the highway and cause a traffic jam. All of these negative externalities are better taken care of by raising the tax on gasoline or the registration tax on clunkers or both.

With appropriate taxes, the market value of a typical clunker would be lower than it is today, but it would still be positive. After all, a clunker has some value just as a spare vehicle in an emergency, and the insurance cost of owning a clunker is actually quite high relative to any reasonable estimate of the cost of externalities. Thus, net net the Cash for Clunkers program is still a federal program to "break windows."

Right, I guess another way to look at it is this: Suppose Congress put a bigger tax on gasoline, say an additional 15 cents/gallon. A clunker that was worth $3500 might now only be worth $2800.

So the effect of the cash for clunkers law would be to go around and obliterate a bunch of cars worth $2800 and under. That's obviously an economic waste and a bad law. [Now I guess you could argue that cars that were worth $300 are now worth negative, but I can't imagine that there are that many $300 cards that people were planning on keeping for very long in the absence of this law.]

Additionally (and this really ticks me off), this law will have the effect of increasing measured GDP (since the former owners of the destroyed cars will buy new ones). The president/Congress basically came up with a feel-good way of gaming the way GDP is computed in order to make themselves look like economic problem-solvers. GDP might be a reasonably measurement of economic health, but it can be gamed.

I agree. GDP gives us one measure of economic vitality, but it is a deeply flawed measure, and it would not tell the full story even if it weren't so flawed. If you hire two formerly unemployed people -- one to dig a deep hole, and the other to fill it in -- then you will have contributed to GDP, but nothing of value would have actually been produced. The same thing happens when lawyers battle over unnecessary litigation, or when people are hired to destroy cars and other people are hired to make cars to replace the ones that have been destroyed.